Indian Money Market

The market that borrows and lends short-term funds is called the money market. The instruments in the money market are short-term in nature and are highly liquid. Money market plays an important function of transferring funds to those economic units who have short-term requirements for funds. In money markets short-term debts instruments in particular are traded by individuals, corporations, government. The short-term instruments are with a maturity of one year or less is issued by those economic units that require short-term funds and lent by people who have surplus short-term funds. The need for money market arises due to the immediate cash requirements of people which do not necessarily match with their cash receipts.


Participants in money market and their roles played 

• Government - Borrower/Issuers
  

• Central Bank- Intermediary
  
  
• Banks - Borrower/Issuers
  
  
• Financial Institutions - Borrower/Issuers
  
  
• Corporate Units - Issuers
  
  
• MF’s, - lenders/Investors
  
  
• Dealers - Intermediaries
  
  
• Discount Houses and Acceptance House- Market makers
  
  

THE INDIAN MONEY MARKET

The Indian market can be classified into organized and unorganized sectors. The unorganized sector consists of money lenders, chit funds, and indigenous bankers. These people satisfy the credit requirement of a large section of the rural masses. The organized part comprises commercial banks in India both public sector and private sector banks and foreign banks. The Reserve bank of India the apex bank is the regulator of the money market in India. It regulates the flow of the credit and money in the economy. To influence the liquidity in the system the RBI intervenes in the money market from time to time either to augment or reduce the supply of credit. The open market operation of the RBI provides signals for other segments of the financial system regarding the future monetary and credit policy of the apex bank

The weakness of the Indian money market

The indigenous bankers and money lenders are still dominating the semi-urban and rural areas in India. In India the organized and unorganized money markets exist side by side. This is a major weakness to the Indian money market. The unorganized money markets follow its own rules and regulation of banking and finance so it does not come into the purview of RBI rules and regulations. In the recent days there are large number of Non-bank Financial companies (NBFC) have come up raising deposits from the public. These NBFC’s perform functions like lending, investing, hire purchase etc. these institutions are not effectively controlled by the RBI.


There is an absence of a well-organized banking system. Though developed to some extent in the recent years their presence is insignificant in rural areas even today. The absence of banking facilities to the rural masses due to slow branch expansion in the country is a matter of concern.

Growth of Money Market in India

While the need for long term financing is met by the capital or financial markets, money market is a mechanism which deals with lending and borrowing of short term funds. Post reforms age in India has witnessed marvelous increase of the Indian money markets. Banks and other financial institutions have been able to meet the high opportunity of short term financial support of important sectors like the industry, services and agriculture. It performs under the regulation and control of the Reserve Bank of India (RBI). The Indianmoney markets have also exhibit the required maturity and flexibility over the past two decades. Decision of the government to permit the private sector banks to operate has provided much needed healthy competition in the money markets resulting in fair amount of improvement in their performance.

Money markets denote inter-bank market where the banks borrow and lend between themselves to meet the short term credit and deposit needs of the economy. Short term normally covers the time period up to one year. The money market operation help the banks rush over the provisional mismatch of funds with them. In case a particular bank needs funds for a few days it can lend from another bank by paying the strong-minded interest rate. The lending bank also gains as it is able to earn interest on the funds lying idle with it. In other words money market provides avenues to the players in the market to strike balance between the surplus funds with the lenders and the obligation of funds for the borrowers. An significant function ofthe money market is to provide a central point for interventions of the RBI to pressure the liquidity in the financial system and implement other monetary policy measures. Quantum of liquidity in the banking system is of dominant importance as it is an important determinant of the inflation rate as well as the formation of credit by the banks in the financial system. Market forces generally indicate the need for borrowing or liquidity andthe money market adjusts itself to such calls. RBI facilitates such adjustments with monetary policy tools obtainable with it. Heavy call for funds overnight indicates that the banks are in need ofshort term funds and in case of liquidity crunch the interest rates would go up.

Depending on the financial situation and available market trends the RBI intervenes in the money market through a crowd of interventions. In case of liquidity crunch the RBI has the option of either dropping the Cash Reserve Ratio (CRR) or pumping in more money supply into the system. Recently to conquer the liquidity crunch in the Indian money market the RBI has released more than Rs 75,000 crores with two back-to-back reductions in the CRR. In adding to the lending by the banks and the monetary institutions, various companies in the commercial sector also issue fixed deposits to the public for shorter period and to that amount become part of the money market mechanism selectively. The maturities of the instruments issued by the money market as a whole, range from one day to one year. The money market is also closely linked with the Foreign Exchange Market throughout the procedure of covered interest arbitrage in which the forward premium acts as a bridge among the domestic and foreign interest rates. Determination of appropriate interest for deposits or loans by the banks or the other financial institutions is a complex device in itself. There are several issues that need to be determined before the optimum rates are determined. While the term arrangement of the interest rate is a very important determinant, the difference between the existing domestic and international

interest rates also emerges as a significant factor. Further, there are several credit instruments which involve similar maturity but diversely different risk factors. Such distortions are accessible only in rising and diverse economies like the Indian economy and need extra care while handling the issues at the policy levels.

Functions:
Money markets are one of the most significant mechanisms of any developing financial system. In its place of just ensure that the money market in India regulate the flow of credit and credit rates, this instrument has emerge as one of the significant policy tools with the government and the RBI to control the financial policy, money supply, credit creation and control, inflation rate and overall economic policy of the State. Therefore the first and the leading function ofthe money market mechanism are regulatory in nature. While determining the total volume of credit plan for the six monthly periods, the credit policy also aims at directing the flow of credit as per the priorities fixed bythe government according to the requirements of the economy . Credit policy as an instrument is important to ensure the availability of the credit in sufficient volumes; it also caters to the credit needs of various sectors ofthe economy. The RBI assist the government to realize its policies related to the credit plans throughout its statutory control over the banking system of the country.

Financial policy on the other hand, has longer term perspective and aims at correcting the imbalances in the economy. Credit policy and the financial policy both balance each other to achieve the long term goals strong-minded by the government. It not only maintains total control over the credit creation by the banks, but also keeps a close watch over it. The instruments of financial policy counting the repo rate cash reserve ratio and bank rate are used by the Central Bank of the country to give the necessary direction to the monetary policy.

Inflation is one of the severe economic problems that all the developing economies have to face every now and then. Cyclical fluctuations do influence the price level differently depending upon the demand and supply situation at the given point of time. Money market rates play a main role in controlling the price line. Higher rates in the money markets decrease the liquidity in the economy and have the effect of reducing the economic activity in the system. Reduced rates on the other hand increase the liquidity in the market and bring down the cost of capital considerably, thereby rising the investment. This function also assists the RBI to control the general money supply in the economy.